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Occupier update - "Willing but Able?"

In
this update, Newton Perkins partner Ian Sonnenthal, looks at the City office market
and assesses how occupiers can negotiate great deals (with Newton Perkins
help!) considering the current market conditions.

“Let’s
start by looking at what has been happening in the market.

After
a sustained strong run of UK economic growth, the pace of expansion has unsurprisingly moderated in the first half of 2017 following Brexit and recent political uncertainty.
The recent rise in inflation and a series of base rate hikes by the Federal
reserve in the United States has prompted a debate about whether the Bank of
England should also begin to raise rates. This appears unlikely in the
near term, although long term interest rates have lifted slightly as some
market participants have reacted to this debate.

However, against this difficult back drop, central London office take up volumes
improved in Q2 of 2017, reaching 1.6 million sq.ft in 87 transactions, which
brings take up at the half year point to 2.8 million sq.ft. This is a
stronger start to the year than 2016 and ahead of the 10 year average.

We
have witnessed some notable transactions in recent months, such as a Deutsche
Bank’s pre-let of the entirety of the future scheme at 21 Moorfields, EC2 which
is c.570,000 sq.ft. Furthermore, NEX Group
Plc leased 120,000 sq.ft at the London Fruit and Wool Exchange, E1.

So
far this year, the TMT sector has accounted for the greatest proportion of take
up at 21%. This is followed by the banking sector, largely due to
Deutsche Bank, now accounting for 15%. The
professional services sector are next at 14% and the insurance and financial
services sector at 10%. There has been continued strong activity from
serviced office providers who have accounted for 7% of take up to date.

However, contrary to the large headline deals being reported,
Newton Perkins research has revealed that supply levels are at an increasingly
high level. Perhaps not so prevalent in the new build/tower market (in
which supply
in the first half of 2017 fell marginally to a very
low vacancy rate of 0.9%) but in the second hand and refurbished sector which has increased
by 3% to 4.3 million sq.ft and accounts for
81% of overall supply.

This
high level of refurbished or second hand stock is pertinent to us at Newton
Perkins as we believe that market figures have been skewed
by headline grabbing deals such as Deutsche Bank. In reality, the high levels of supply (especially
in the sub 20,000 sq.ft market) suggests we
are witnessing a shift towards a tenants market.

So
what does this mean for occupiers? Occupiers needing new offices are starting
to be met by a never ending list of available properties and inducements, and
there are certainly opportunities for the “willing
and able” occupier.

For
the “willing”
occupier (i.e. with no existing premises to get rid of) the basket of
inducements can still include dealing rents lower than quoting levels,
inducement packages (offering c. 2 – 2.5
months’ rent free for each year of occupation) and/or lease flexibility to
break in, say 3 or 5 years. For companies boasting a strong balance
sheet, some landlords will still offer to fund fit-out costs with minimal
requirements for security deposits. The city of London also continues to offer the lowest central London outgoings as compared with the West
End and mid-town equivalents.

However,
it is not all roses. Many occupiers are not able to capitalise on the
opportunities as they are tied into lease obligations with little or no chance
of surrendering. The option is to re-let unwanted accommodation and become an
accidental landlord but this path requires the offer of similar inducements in
order to attract new tenants. To add pain, the government’s
change of policy on rates relief for unused or empty property has doubled the
holding costs.

All
is not lost however. Over the past 10 years many UK companies have moved
to shorter term leases or have break options. Landlords faced with the
fear of having an empty property will still offer reasonable rent free periods
and renegotiated lease terms in order to extend the stay of their existing
tenants. However, many occupiers fail to appreciate the opportunity and
the strength of their negotiating position or simply leave it too late to start
the discussion.

For
companies requiring less than 10,000 sq.ft, a 9-12 month head start is usually needed before lease
expiry or break option in order for constructive discussions to take place with
the landlord. Larger companies generally require a longer leading time
and we recommend up to 18 months ahead.

So
our advice is that occupiers should take an active look at their lease, break
options and opportunities to move and/or restructure leases. They should
seek to exploit the opportunities presented by the current market…where they
are “willing and able”
to do so.”